Pessimism now competes with uncertainty as the prevailing sentiment on Wall Street. Not only are forecasters lowering US growth prospects, but Ben Bernanke sounded almost fatalistic last week on whether the Federal Reserve could do anything to reverse things. With interest rates this low – just 3.7 per cent on a 30-year mortgage – another few basis points would not make much difference. Since Congress has forsworn further stimulus, and export growth is tapering off, it is unclear where the next phase of America’s recovery will come from. When they peer through their glass darkly, the experts only see paralysis.
Which is why the two bankrupt Californian cities of Fontana and Ontario in San Bernardino County offer such a bracing jolt to Washington’s passivity. Where the Obama administration has largely failed to ease the foreclosure crisis, the two cities recently announced plans to seize loans on “underwater” homes (those valued at less than the mortgages). The two were driven to bankruptcy largely by mass foreclosures, which shut down communities and killed economic activity. In despair at banks’ reluctance to renegotiate mortgages, they plan forcibly to buy and restructure them.
To put it mildly, such a step would be radical. Eminent domain, or compulsory purchase, is usually invoked for the acquisition of private lands for public use, such as roads and airports. It has never been used for private loans.
Given how easily it crushed far milder efforts by President Barack Obama, Wall Street is unlikely to take kindly to a challenge from two Californian backwaters. It is already playing hardball. Last week the Securities Industry and Financial Markets Association, one of the largest lobby groups, said it would fight this “unquantifiable new risk” in the courts. It also threatened an industry boycott – a strike on new mortgages – of anyone living in cities that went ahead. Several non-Californian cities are reportedly looking at it.
Forcible restructuring may be a red line for Wall Street. Yet there is little new thinking to be found in Washington. US growth is slowing sharply and there is a now a material risk America could tip back into recession next year. In spite of talk of the US housing market having bottomed out, home prices are still a third below their peak and more than 11m remain underwater. Even if the housing sector has stopped its descent, it is unlikely to be a large boost to US growth until the foreclosure crisis has worked out.
At some abstract level America’s opinion formers grasp that balance-sheet recessions take time to work off – an average of five to seven years, according to the economists Kenneth Rogoff and Carmen Reinhart. Yet they still leap on anything that suggests otherwise. Any sign of revival, such as the housing market, is emphasised. Anything pointing the other way, such as retail sales, which have fallen for three straight months, or job creation, which has stalled, are aberrations. The Pollyannas may know America is grappling with a different kind of recession. But they clearly do not feel it.
It is not for lack of data. According to a paper just published by Richard Vague and Steven Clemons, the US outlook is likely to be dismal for several more years. Combined public and private debt is almost 250 per cent of gross domestic product – above any other developed country except for Japan. The US has been quicker than other economies to push through deleveraging. But private debt, which offers a better predictor of growth than public, is still higher as a share of America’s GDP than anywhere in Europe. In their study of the only two comparable recessions in the last century – America in the 1930s and Japan since 1990 – the authors find scant evidence the US is about to turn the corner.
All of which gives the California rebels real significance. They may succeed in taking on Wall Street where Mr Obama has failed. Back in 2009, Chris Dodd, the then Democratic chairman of the Senate banking committee, complained about White House “ambivalence” on a bill that would have allowed judges to “cram down” residential mortgages. Mr Obama allowed it to die. His administration has been equally halfhearted in support of initiatives to incentivise the banks to renegotiate mortgages.
Whether it is the White House, the banks, or the borrowers themselves, a spirit of inertia has stymied efforts to tackle a big obstacle to US recovery. No one should be surprised the recovery is still inert.
The California rebellion also has the potential to shake up politics. Most people think the Obama administration bailed out Wall Street and left Main Street to its fate. Yet Wall Street has done little to thank Mr Obama for his largesse. Bizarrely, some Wall Street executives think Mr Obama has betrayed them. By a ratio of three to one, Mitt Romney is outraising Mr Obama among financial donors. As the saying goes, no good deed goes unpunished.
Yet nothing concentrates the mind like a bankruptcy. Last week Brad Miller, a North Carolina congressman, said Wall Street’s influence may not work so well in bankrupt cities. “Wall Street’s power in Washington may be as useless in defeating a proposal in San Bernardino as strategic nuclear weapons are in fighting an insurgency,” he said. In an age of stagnation, it is good that politicians somewhere are still trying to shake things up.